Saturday, Jun 27, 2009
Dubai: The US Treasury's stress test of 19 US banks was positioned as a confidence-building - not a solvency-ensuring - measure. Islamic banks need to undertake a customised stress test of their own.
The test should showcase a very different banking model that has so far avoided major bailouts and bankruptcies.
The subprime-induced credit crisis has flushed out the false premise that Islamic banking and fin-ance was disconnected from conventional finance. Islamic finance operates in the same tax, regulatory and legal environment and has the same vulnerabilities of liquidity and confidence crisis as the conventional sector.
Furthermore, as Islamic finance is young, its regulations are fragmented globally. Islamic finance has also been accused of being opaque, which can perhaps also be attributed to the embryonic nature of the industry.
In addition, because of the Sharia prohibitions on riba (interest), gharar (uncertainty) and misyr (speculation), the Islamic bank system has greater exposure to real estate and stock loans, with fewer risk and liquidity management tools and an excessive reliance on commodities (murabaha).
The Islamic finance industry also still has an incomplete information offering for customers, requires more qualified personnel and suffers from the usual complaint about lack of standards.
Should the stress test be extended to Islamic investment banks' wholesale divisions as well? The wholesale divisions of Islamic investment banks seem more vulnerable to the market movements of private equity and real estate.
The seal of approval after a stress test would objectively show that the Islamic finance model works better, or at least differently, than its conventional counterpart in a crisis environment.
While each country's central bank would be the natural lender of last resort for Islamic banks that fail stress tests, the multilateral Saudi Arabia-based Islamic Development Bank could have a role to play here by offering capitalisation funds in return for equity stakes.
The methodology of the stress test will be most important, hence it must be transparent, comprehensive and flush out impaired Islamic assets. This naturally leads one to ask if a "bad Islamic bank" or even asset management company should be set up to buy off-loaded assets as part of a cleansing process, assuming there's no Sharia prohibition issues such as discounting.
Potential top-line outcomes of an Islamic finance stress test could include:
By Rushdi Siddiqui, Special to Gulf News
Gulf News 2009. All rights reserved.
